Application:

The Costs of Taxation

Economics, Investment, and Taxation
Consumer Surplus vs Producer Surplus
• Consumer Surplus
• Definition: The difference between the maximum price consumers are
willing to pay and the actual price they pay.
• Benefit: Represents the extra satisfaction or utility consumers receive from
purchasing a product at a lower price than they are willing to pay.
• Producer Surplus
• Definition: The difference between the actual price producers receive and
the minimum price they are willing to accept.
• Benefit: Represents the extra profit or benefit producers receive from
selling a product at a higher price than their minimum acceptable price
Who invented
taxation?
A) The Pharaohs of Ancient Egypt
B) The Sumerians of Mesopotamia
C) The Greeks
D) None of the above; taxation has
been a concept used by various
civilizations throughout history
without a single inventor.
Overview
Historical Significance:
• Taxes have been a major topic of political debate throughout history,
such as in the American Revolution.
Necessity of Taxation:
• Despite debates, most agree that some level of taxation is necessary
for a civilized society.
Overview
Economic Impact:
• Taxes affect prices, quantities, and the welfare of market participants.
• They raise revenue for the government but can also create economic
distortions and reduce overall welfare.
Understanding Tax Effects:
• Understanding the effects of taxes on welfare requires considering
their impact on buyers, sellers, and the market as a whole.
Deadweight Loss
• Deadweight loss represents the loss of economic efficiency that
occurs when the equilibrium outcome in a market is not achieved or
is distorted.
• This can happen due to various factors, such as taxes, subsidies, price
controls, or monopolies.
The Deadweight Loss of Taxation
Tax Incidence:
• The impact of a tax is the same regardless of whether it is levied on
buyers or sellers.
Effect on Demand and Supply:
• Tax on buyers: Shifts the demand curve downward by the tax amount.
• Tax on sellers: Shifts the supply curve upward by the same amount.
The Deadweight Loss of Taxation
Price and Quantity Changes:
• Increases the price paid by buyers.
• Reduces the price received by sellers.
• Creates a price wedge between the two.
• Decreases the quantity sold below the level without the tax.
Tax Burden Distribution:
• Depends on the elasticities of supply and demand.
• Not determined by how the tax is levied.
How a Tax Affects Market Participants
Impact on Buyers:
• Benefit is the amount they are willing to pay for the good.
Impact on Sellers:
• Benefit is their revenue minus production costs, known as producer
surplus.
Impact on the Government:
• Receives tax revenue (T * Q) from the tax.
• Revenue can be used for public services or assistance programs,
benefiting society.
How a Tax Affects Market Participants
Tax Revenue:
• Represented by a rectangle in a supply and demand graph.
• Height: T (tax size)
• Width: Q (quantity sold)
• Area: T * Q (total tax revenue)
The Determinants of the Deadweight Loss
• Role of Price Elasticities:
• The size of the deadweight loss depends on the price elasticities of supply and
demand.
• These elasticities measure how much quantity supplied and demanded
respond to changes in price.
The Determinants of the Deadweight Loss
Impact of Supply Elasticity:
• Inelastic Supply: If the supply curve is relatively inelastic (responds
slightly to price changes), the deadweight loss is smaller.
• Elastic Supply: If the supply curve is relatively elastic (responds
substantially to price changes), the deadweight loss is larger.
The Determinants of the Deadweight Loss
Impact of Demand Elasticity:
• Inelastic Demand: If the demand curve is relatively inelastic, the
deadweight loss is smaller.
• Elastic Demand: If the demand curve is more elastic, the deadweight loss is
larger.
Behavioral Changes:
• A tax induces buyers to consume less and sellers to produce less.
• This reduces the equilibrium quantity in the market below the optimal
quantity.
Effect of Elasticities:
• The more responsive buyers and sellers are to price changes (higher
elasticities), the larger the deadweight loss of a tax.
Deadweight Loss and
Tax Revenue as Taxes Vary
Deadweight Loss:
• The reduction in total surplus resulting from the tax.
• Represented by the area of the triangle between the supply and
demand curves.
Effect of Increasing Tax Size:
• As the size of the tax increases, the deadweight loss grows larger.
• The deadweight loss rises more rapidly than the size of the tax due to
the geometric properties of a triangle (the area depends on the
square of its size).
Deadweight Loss and
Tax Revenue as Taxes Vary
Tax Revenue:
• The size of the tax multiplied by the quantity of the goods sold.
• Represented by the area of the rectangle between the supply and
demand curves.
Effect of Increasing Tax Size:
• Initially, as the tax size increases, tax revenue grows.
• However, beyond a certain point, the tax becomes so large that the
market shrinks significantly, causing tax revenue to fall.
Conclusion
Markets and Economic Activity:
• The Ten Principles of Economics state that markets are usually a good
way to organize economic activity.
Impact of Taxes:
• Taxes reduce the benefits of market efficiency.
• They transfer resources from market participants to the government.
• Taxes distort incentives and market outcomes.
Conclusion
Microeconomic Perspective:
• Microeconomists study how to design a tax system to balance equality and
efficiency.
• Macroeconomic Perspective:
Macroeconomists examine how taxes influence the overall economy.
• They explore how policymakers can use the tax system to stabilize
economic activity and achieve growth.
Importance of Tax Analysis:
• The analysis of taxes helps understand their economic impact.
• Taxation is a significant topic, often studied in both microeconomics and
macroeconomics.